Which of the following best characterizes the circular flow of income in an economy?

• A. It shows how government sets prices for goods and services in the market.
• B. It explains how international trade affects domestic income levels.
• C. It illustrates the continuous movement of money, goods, and services between households and firms.
• D. It describes the process by which firms determine their production costs.

Answer: (C)

Verified step by step guidance

1. Step 1: Understand the concept of the circular flow of income, which is a fundamental model in microeconomics illustrating how money, goods, and services move continuously between different sectors of the economy.
2. Step 2: Identify the main participants in the circular flow model: households and firms. Households provide factors of production (like labor) to firms, and in return, they receive income (wages, rent, profits).
3. Step 3: Recognize that households use their income to purchase goods and services produced by firms, creating a flow of expenditure back to firms.
4. Step 4: Note that this model emphasizes the continuous and reciprocal nature of economic activity, showing how money flows from firms to households as income and back from households to firms as consumption expenditure.
5. Step 5: Compare the given options and conclude that the correct characterization is the one that highlights this continuous movement of money, goods, and services between households and firms.